Ways They Cook Books: What You See May Not Be What You’re Buying

By Ron Beilin and Paul DelFino

The business news over recent months has done much more than report the steep slide of the stock market. Overall, confidence in business people, distrust of the financial establishment, and a new mindset for the terms CEO and CFO are the byproducts that will linger long after the stock market rebounds with normal cycles.

The long aspired-for titles of CEO and CFO have taken on an aura of shady dealing and distrust. As Watergate did to politics, what has been revealed about Enron, WorldCom, and others yet to surface, will redefine our thinking for some time.

Should we be surprised? Probably not. Since the beginning of time and the first “transaction” between cave dwellers, “creative accounting” has been a tool to mask weakness and inflate value. The process and game is not limited to Fortune 1000 enterprises. In reality, it is easier for a one million dollar teleservice company to “creatively” position themselves, because the numbers of most small businesses are not audited.

Small businesses normally engage accounting firms to “compile” their numbers. A compilation is merely the correct presentation of the numbers given an accountant. A “review” is a spot check of accuracy and an “audit” is certification of accuracy and consistency. Audits are expensive and most small businesses do not make the investment and merely meet the need for end of year reporting with a compilation.

Knowledge of this is important since the telemessaging industry is ripe for consolidation. This is due to:

The capital investment and scale required for emerging technology.

The average size of firms in the industry.

The opportunity for efficiencies with consolidation and overhead reduction.

The above suggests there will be an increase in merger and acquisition activity. If you plan on making mergers and acquisitions, be forewarned: You are entering a field filled with mines and potential expenses.

Let the Buyer Beware

We have not been surprised by the news of accounting irregularities. Over the years, we have encountered scores of “creative” techniques by business people hoping to look better for courtship and even for their banker. This is not new news and will more than likely remain a fact until the end of time.

Here is a sundry list presenting a sampling of techniques and “creative” adjustments to numbers that you should watch for when evaluating a business.

Timing Issues

Deferring current expenses to another accounting period.

Accelerating discretionary expenses to the current period.

Keeping cash-received records open after the end of a period; closing disbursement records early.

Depreciating or amortizing at different rates.

Writing off future depreciation or amortization in the present accounting period.

Liquidating reserves against anticipated returns to shift sales revenue to a later period.

Recognizing revenue before it is fully earned or while significant contingencies exist.

Delaying publication of financial results.

Making unusual entries at or near the end of an accounting period.

Interpretation

Not writing off bad loans or worthless assets.

Over or under valuing investments, intangibles, and other assets, especially difficult ones like excess inventory, private-placement securities, and contract rights.

Many business opportunities involve smaller companies where certified statements are simply not available. Consider examining the organization’s books, ledgers, bills, invoices, bank statements, checks, and other supporting documentation thoroughly, with your own eyes

Ron Beilin & Paul DelFino are the principals of the Consulting Firm, “Opportunity, Inc.” For nearly fifteen years they have assisted entrepreneurs in growing their businesses, hurtling economic downturns, and merger and acquisition activity.